American Investors Should Not Ignore This Car Company

Jun.21.14 | About: Toyota Motor (TM)


Toyota gets largely ignored by American investors since most of the attention goes to Ford, GM and Tesla.

Toyota is unique as it has been able to post profitable growth in all segments (from cheap sedans to the luxury brand, Lexus).

The company is cheap both in terms of trailing and forward figures.

In the last few years, many American investors have bought shares of automobile companies such as Ford (NYSE:F), General Motors (NYSE:GM) and Tesla (NASDAQ:TSLA), and this is becoming one of the most popular industries in the stock market. I find it interesting that a lot of American investors are not interested in betting their money on non-American automakers. Even though there are several American car companies that offer cheap valuation, Toyota (NYSE:TM) might be offering a great investment opportunity.

At Seeking Alpha, the Ford stock has 76,224 followers, Tesla has 56,260 followers and General Motors has 23,663 followers, showing that these three companies are highly popular amongst American investors. Toyota trails these companies from far behind with only 4,345 followers despite being the world's largest car company by market cap. What gives? Are Americans missing out on a great investment opportunity here?

The current state of the automobile industry

After falling on its knees badly during the last recession, the automobile industry has been recovering nicely around the world. The American automobile market now posts sales figures similar to those it was posting prior to the recession. The European market took a much longer time to recover but it has been doing better recently. The Asian and Latin American markets continue to drive growth even though they frequently suffer from currency fluctuations and political instability.

Even though the American automobile market is doing really well, it is far from reaching the peak. Currently, the average age of American cars is still above 10 years and many people will be replacing their older cars with newer models. I must add a word of caution and note that those who are holding on to their older cars for more than 10 years rather than buying new ones are likely to have lower income than those that change cars frequently; therefore, once they decide to buy newer cars, they might opt for cheaper models with lower margins. Apart from this, the American car market will be reliably strong for the next few years unless another global recession comes to hit us.

In Europe, car sales fell year after year for nearly a decade and it has been showing small bits and pieces of improvement in the last few quarters. It is unlikely that the car companies will post double-digit sales growth in Europe as they did in the USA last year, because the European economy still struggles with an unusually high rate of unemployment. Things should still be improving in the continent in baby steps. In Europe, gasoline is far more expensive than it is in the US due to high taxation, and Europeans should be replacing their old cars with newer ones that consume less fuel.

Where does Toyota stand in all of this?

Toyota is in a unique position in the automobile industry. The company enjoys a few advantages over its American counterparts. Most car companies are really good at one thing but they can't seem to get everything right at once. For example, Ford is great at building pick-up trucks and SUVs, but the company's luxury segment has been less than impressive for as far as I can remember. GM is another company that saw limited success with its luxury brands, especially in the recent years. Unlike these companies, Toyota saw significant success in its regular brands as well as its luxury brands. Toyota's Lexus brand is miles ahead of the competition in terms of sales volume, global image and profitability.

Toyota saw some setbacks in China due to political reasons. In this particular country, Ford, GM and the German car companies were able to take advantage of this setback and these companies posted strong growth while Toyota got boycotted by the Chinese due to political frictions between China and Japan. Recently things have been improving for Toyota in the country and the company has been posting some growth in China, even though it may take as much as a couple years before Toyota fully restores its growth rate in China.

New line of vehicles will drive growth

Toyota is currently in the process of refreshing its fleet of vehicles. The company is planning to build new set of vehicles that have better fuel consumption and better overall driving experience. It is very typical for car companies to refresh their line of vehicles every 4-5 years in order to give their vehicles a new look and modernize many of the functions of these vehicles.

Currently, Toyota is shifting its focus on more fuel-efficient vehicles and the company is also gearing towards selling more vehicles in emerging markets. In countries like India and China, there is a huge shift away from pollutants and Toyota's new line of energy-efficient vehicles should earn the company considerable market share. As Toyota increases its production rate, cost-per-vehicle will continue falling and the company will make a better profit from each vehicle it sells. Last year Toyota produced more than 10 million vehicles and the company has been investing capital towards increasing the production rate further. The company seems to be completely over with the effects of the 2011 earthquake, which affected Japan's industrial output negatively for the next 2-3 years.

Japan is committed to keep the Yen cheap

Japan's commitment to keep the Japanese Yen cheap will help Toyota's sales volume growth. This will be particularly helpful in North America and Europe where local currencies are stronger than the Japanese Yen. Last year, the weak Yen helped Toyota's volume nicely as the company sold 441,000 more vehicles compared to the previous year, and as a result of this, Toyota's operating margin rose from 6.0% to 8.9% and net profit margin rose from 4.4% to 7.1%. I must add a note of caution, if the Japanese Yen falls too sharply too soon, this might hurt Toyota as much as it helps the company because the company still conducts most of its business in the Japanese currency. In the last few years, Toyota has been making a move towards shifting its operations and production capacity away from Japan and this will reduce the company's dependency on one currency in the long run.

How about valuation?

Toyota currently trades for roughly 10 times trailing earnings, 1.3 times book value, and the company's PEG ratio is as low as 0.6. Since the automobile industry is highly cyclical, we see a lot of low valuations in this industry and it is not uncommon to see an established car company with a single-digit P/E. This is why Toyota's valuation may not look impressive at first. One advantage Toyota has over other car companies is the predictability and consistency of the company's margins, balance sheet and market share over the years. Toyota sees less volatility than other companies in many performance metrics and this makes Toyota a relatively safer stock. Furthermore, all of Toyota's brands show similar performance and the company can rely on all of its different products for profitability, unlike many other companies where certain products pick up the slack of other products. From compact cars to big trucks, from cheap sedans to luxury models, Toyota performs well across the board. This is what makes Toyota so special. Toyota trades for about 8 times forward earnings ex-cash against a market average of 18. Things can get interesting for the company's investors if it can meet or beat analyst goals this year and the next.

Disclosure: The author is long F, TM. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.